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Bank Foreclosures Can Be a Bargain, but Be Careful

Buying a foreclosed home can be a great way to get more house for less money. However, there are several issues regarding bank foreclosures that buyers in traditional retail home sales don't have to worry about.

Source: Flickr user respres.

For example, many foreclosures have been empty for several years while the bank prepares to sell them. This can mean tens of thousands of dollars in neglected maintenance you'll have to pay for.

Maintenance issues

A home that is simply dirty is not necessarily a problem. However, there are a few specific issues to check for that can cost big bucks to repair.

For example, mold is a common problem in neglected homes. If the drywall is infested with mold, there is no way to get rid of it other than replacing the drywall. This can easily cost thousands of dollars, especially if the problem is widespread.

Source: FEMA.

Another big problem area is roof maintenance. If even a small roof leak has been neglected, there could be extensive water damage underneath. Water is the No. 1 enemy of pretty much everything made by man, so you want to be sure it's kept out of places where it shouldn't be.

Financing difficulties

Another major problem for potential buyers of bank foreclosures is getting approved for a mortgage.

Because of all the potential maintenance issues, banks may be reluctant to extend financing for a foreclosed home. And if you're trying to buy a property at an auction (where the best deals usually are), you'll need loan preapproval for the maximum you're willing to spend before you bid, which means you and your inspector will never even set foot in the house before applying for the loan. Obtaining a mortgage on a house when the bank is unaware of its condition is no easy task.

And bear in mind that since the house is unoccupied, you'll be shopping without a seller's disclosure. In typical real estate transactions, a seller's disclosure is a form in which the seller is legally obligated to tell you the condition of certain parts of the property and let you know about any defects or problems with the home, such as lead-based paint in the walls. However, banks are exempt from providing disclosures on foreclosed homes they own.

Essentially, this means you're applying for financing on a property, and nobody knows what's wrong with it. As you can imagine, it's tough to get a lender to risk its money on a deal like this. Generally, you'll need excellent credit and a substantial amount of collateral in order to qualify.

Source: Flickr user 401(k) 2013.

You'll also face stiff competition from cash buyers, who are much more desirable buyers to banks, given the difficulties of obtaining financing.

Property damage

The bank is unlikely to repair significant damage to a house before selling. It has already lost money on the property and simply can't justify sinking any more into repairs.

Angry homeowners sometimes intentionally damage their houses when they find out they're being forced out. I've seen smashed windows, toilets, and fixtures, and even holes in the middle of the floor. In other instances, damage caused by vandalism is common, especially if the house has been uninhabited for a long period of time.

Source: Pixabay.

Although it's not really "damage," owners facing foreclosure are known to steal valuable items from the home before moving out, including appliances and even plumbing supplies. Many foreclosed homes are missing refrigerators, ranges, dishwashers, and toilets.

The takeaway

Bank foreclosures can absolutely be a good value, but know that these homes are cheap for a reason. Your goal when buying a foreclosure should be to get a "discount" big enough to more than compensate you for the work that needs to be done.

You don't want to save $50,000 off the market value of a home only to learn after closing that it needs $100,000 in repairs just to become habitable. The best-case scenario looks more like the opposite situation, where you save $100,000 and only need to sink $50,000 into the home.

When looking at bank foreclosures, be sure to look past all of the clutter and dirt and keep an eye out for expensive problems. If you can avoid costly repairs like a new roof or new plumbing, it's definitely possible to get a great deal on your next home with a foreclosure.

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Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!
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